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Credit crisis, Part II: Lehman's loss stuns investors

Wall Street has been worried for weeks that Lehman Bros. was facing another hit from the credit crisis.

Turns out the market wasn’t worried enough.

The securities firm pulled back the curtain on its fiscal second-quarter results today, and the numbers were worse than even the most bearish estimates.

Lehman said it expected to lose $2.8 billion, or $5.14 a share, in the quarter ended May 31, far more than analysts’ forecasts. The company also said it was raising $6 billion in fresh capital -- $2 billion more than projected.

The loss estimate and the looming dilution from the capital injection sent investors crowding for the exits. The stock was off $4.27, or 13.2%, to $28.02 -- a five-year low -- at about 11:30 a.m. PDT. Lehman's numbers were weighing on financial stocks in general, which are having another bad day.

"Today’s results were far worse than anyone had anticipated," Goldman Sachs & Co. analyst William Tanona wrote in a note to clients.

Lehman said the red ink would stem from more write-downs of securities it holds and from trading losses.

The company tried to show that it had made some progress with its troubled investment portfolio. It cut its exposure to risky residential and commercial mortgages by as much as 20% in the quarter.

Lehman also said it sharply boosted liquidity -- basically, cash on hand to prevent a Bear-Stearns-like run on the bank -- to $45 billion from $34 billion at the end of the first quarter.

But investors’ concern is that Lehman had appeared to be weathering the credit crisis in the first quarter, only to divulge this latest round of write-downs. The company had turned a profit of $489 million in its fiscal first quarter.

To bolster its balance sheet, Lehman said it was raising $4 billion by selling 143 million shares of common stock at $28 each, which will boost outstanding shares by 26%. It’s also selling $2 billion of preferred shares that will pay an 8.75% annual dividend yield.

Tanona said he had expected investors’ reaction to be negative "given the size of the loss and the book value deterioration."

But he also noted that many "short sellers" had been targeting the stock, selling it in recent months in anticipation of more trouble. The short position in Lehman has ballooned to 76 million shares from 56 million at the end of March.

"We would expect the stock to move higher throughout the day as we believe you will see some investors covering their short positions," Tanona said.